As anticipated, the S&P 500 gapped down below support of its June low, but the bulls immediately stepped in, triggering a broad-based rally. Renewed tech strength enabled the Nasdaq Composite to lead the way with a 1.2% gain. Since the Nasdaq showed the most relative strength during the market's recent correction, it's not surprising that it was also the first index to surge higher when the broad market finally bounced. The S&P 500 rallied 0.9%, while the Dow Jones Industrial Average climbed 0.7%. The small-cap Russell 2000 and S&P Midcap 400 indices were higher by 1.5% and 1.1% respectively. After the initial gap down, stocks trended steadily higher before closing at their intraday highs. Money rotated out of the S&P and Dow, and into the Nasdaq and Russell, enabling technology-related issues to register strong performances.

Volume in both exchanges ticked slightly higher. Total volume in the NYSE increased by 3%, while volume in the Nasdaq came in 1% above the previous day's level. Given the Nasdaq's strong performance, one might have expected a bigger surge in turnover. However, the volume levels weren't bad considering that the FOMC will announce their decision on interest rates and economic policy tomorrow. Traders generally step aside ahead of key economic data. Volume in the NYSE exceeded its 50-day average, but fell just shy in the Nasdaq. Market internals were solid. Advancing volume in the Nasdaq exceeded declining volume by a margin of 5 to 1. The NYSE ratio was positive by 7 to 2.

In yesterday's commentary, we mentioned that the Nasdaq Composite was the only one of the major stock market indexes still trading above its 50-day moving average. The morning gap down in the futures caused the Nasdaq to eventually trade below its 50-day MA too, but that brief dip below key support triggered buy programs that ignited the rally. It's on intraday probes below pivotal support/resistance levels that markets often reverse because the "smart money" runs stops and grabs shares at the best possible prices. In this case, the opening gap down to a new June low in the S&P 500, combined with the Nasdaq's open below the 50-day MA, created the perfect reasons for traders to step up to the plate. These obvious tests of closely-watched support levels are also the reasons we warned subscribers to be prepared for a volatile morning yesterday:



The Nasdaq Composite not only zoomed back above its 20-day EMA, but it also made a 61.8% Fibonacci retracement from the high of its June breakout attempt down to yesterday morning's low. Since the 61.8% retracement level is considered the last major line of defense when an index bounces off its low, the Nasdaq could easily rally back to its multi-year high if it holds at or above yesterday's high throughout today's session. Obviously, a negative reaction to this afternoon's Fed announcement on interest rates is the biggest risk factor that could throw a wrench in the works.

As for the S&P 500, it has a lot more ground to make up. Despite the rally, the broad-based index still remains below resistance of its 50-day moving average. It also bounced to just the 38.2% Fibonacci retracement level from its June high down to yesterday's low. An additional gain of 0.8% is required just to push the S&P up to its 61.8% retracement:



While a positive reaction to the Fed could easily kick the S&P and Dow back into gear, there is definitely more profit potential and lower risk on the long side of the Nasdaq right now. This is especially true with the tech stocks and ETFs, many of which have suddenly begun to show rather bullish chart patterns.

On Tuesday, we covered half of our short position in the StreetTRACKS Metals and Mining (XME) when it tested support of its prior low from June 12. Yesterday, it gapped down to within 50 cents of our original downside profit target. When buyers began stepping in shortly after the open, we sent an intraday e-mail alert to notify subscribers we were taking profit on the remaining shares. Our average gain on the full position was 3.5 points (5.5%). Our short position in the iShares Austria Index (EWO) is showing an unrealized gain of just under 1 point, while the SDS long position is presently flat.

Tuesday's weakness benefited our short positions, but it also caused our long position in the Semiconductor HOLDR (SMH) to hit its stop. Nevertheless, SMH was taken primarily as a hedge against our short positions, for which purpose it served well. Also, the capital loss in SMH was only about one-third the size of the actual gain in the XME trade. Despite the strong breakout and impressive relative strength SMH exhibited on June 21, weakness in the S&P and Dow weighed too heavily on it. SMH fell all the way back down to below the low of the volatility expansion breakout bar, which is where our stop was placed. Ironically, SMH raced back with a vengeance yesterday, but that's just part of the business we must deal with sometimes. If SMH consolidates in a tight range over the next week, it may set up for a low-risk re-entry point. Until then, it could remain choppy within its range.

At 2:15 pm EDT, the Federal Reserve Board will announce their decision on interest rates and, more importantly, the forward-looking stance on economic policy. Though rates are widely expected to remain unchanged, Wall Street will be looking for hints in the Fed commentary of whether or not inflation remains a risk. As always, expect calm action in the morning, followed by a storm of volatility in the last 90 minutes. There are a few ETFs we are stalking for long entry, but we will wait to see the market's reaction to today's afternoon announcement. Remember it's not what the Feds actually say, but the market's reaction that matters.

Open ETF positions:

Long - SDS
Short - EWO

Deron Wagner is the Founder and Head Trader of both Morpheus Capital LP, a U.S. hedge fund, and Morpheus Trading Group, a trader education firm launched in 2001 that provides daily technical analysis of the leading ETFs and stocks. For a free trial to the full version of The Wagner Daily or to learn about Wagner's other services, visit MorpheusTrading.com or send an e-mail to deron@morpheustrading.com.